Director Liability in Oppression Actions

We recently wrote an article that provides an overview of the oppression remedy in shareholder disputes. This article discusses the particular issue of when directors will be held personally liable. The Supreme Court of Canada provided much needed guidance on this issue in Wilson v Alharayeri, 2017 SCC 39 (issued July 13, 2017).

Background

The respondent, Mr. Alharayeri, was the President, CEO, minority shareholder and director of Wi2Wi (the “Corporation”), a company incorporated under the Canada Business Corporations Act (“CBCA”). Mr. Alharayeri held common shares and two classes of performance-linked convertible shares that were convertible into common shares if the Corporation met certain financial targets in the 2006 and 2007 fiscal years (class “A” and class “B” shares). The appellant, Mr. Wilson, held similar convertible shares of a separate class (class “C” shares)

In March 2007, Mr. Alharayeri began negotiating a merger with another business and also agreed to sell some of his own shares of the Corporation to that other business. Mr. Alharayeri did this without providing notice to the Corporation. The Corporation learned of Mr. Alharayeri’s discussions, which led to his resignation as President, CEO and director of the Corporation in June 2007.

Mr. Wilson became the Corporation’s President and CEO. The Corporation’s board then consisted of seven directors, but the audit committee was comprised of only two directors: Mr. Wilson and Dr. Hans Black.

In September 2007, the Corporation’s board decided to issue a private placement of convertible secured notes to its existing shareholders (the “Private Placement”). The Private Placement would be highly dilutive to existing common shareholders who did not participate in it.

Prior to the Private Placement, the Corporation’s board accelerated the conversion of the appellant’s class “C” shares into common shares, despite concerns by the auditors that the financial test for the class “C” shares had been met.

However, Mr. Alharayeri’s class “A” and class “B” shares were never converted into common shares, despite his requests for conversion at board meetings, in emails and otherwise. Mr. Wilson and Dr. Black refused to convert Mr. Alharayeri’s shares because of concerns as to whether it was appropriate to permit the conversion given the respondent’s conduct prior to his resignation.

As a result of the Private Placement, Mr. Alharayeri’s common share holdings were significantly diluted. Further, the value of Mr. Alharayeri’s convertible class “A” and class “B” shares was also greatly reduced.

The respondent filed an application for oppression under section 241 of the CBCA against four of the Corporation’s directors, including the two members of the audit committee: the appellant, Mr. Wilson, and Dr. Black.

Supreme Court Decision

The central question addressed by the Supreme Court was whether the trial judge appropriately exercised the remedial powers provided in s. 241(3) by holding Mr. Wilson personally liable for the oppression.

The Court adopted the criteria articulated in Budd v Gentra Inc. (“Budd”) for when directors will bear personal liability under the oppression remedy (the “Budd Test”). According to the Budd Test, personal liability arises where:

the director or officer is implicated in the oppressive conduct; and

the oppression remedy order is a fit in all the circumstances.

In determining whether the imposition of personal liability is “fit in all the circumstances”, four general principles were articulated by the Supreme Court to provide guidance in fashioning an order under section 241(3). These guidelines are summarized as follows:

1. The oppression remedy request must be a fair way of dealing with the situation. The following situations provide indicia for whether a personal order is fair:

where directors obtain a personal benefit from their conduct;

where directors have increased their control of the corporation by the oppressive conduct;

where directors have breached a personal duty they have as directors;

where directors have misused a corporate power; or

where a remedy against the corporation would prejudice other security holders.

The Supreme Court stressed that this is not a closed list, however personal benefit and bad faith are “hallmarks of conduct properly attracting personal liability”.

2. Any order made under section 241(3) should go no further than necessary to rectify the oppression. In other words, remedial orders under section 241(3) may only respond to the expectations derived from an individual’s status as a security holder, creditor, director or officer.

3. Any order made under section 241(3) may serve only to vindicate the reasonable expectations of security holders, creditors, directors or officers in their capacity as corporate stakeholders.

4. A court should consider the general corporate law context in exercising its remedial discretion under section 241(3). This means that the statutory oppression remedy is not to be deployed as a substitute for other forms of statutory or common law relief.

The Supreme Court ultimately upheld the trial judge’s decision to hold the appellant personally liable for oppression under section 241. Mr. Wilson and Dr. Black played the lead roles in board discussions preventing the conversion of Mr. Alharayeri’s class “A” and class “B” convertible shares. It was this role which led the trial judge to conclude that Mr. Wilson and Dr. Black were implicated in the oppressive conduct, therefore satisfying the first prong of the Budd Test.

The Supreme Court also affirmed the trial judge’s finding that the oppression remedy was fit in the circumstances. There were several reasons for this:

Mr. Wilson accrued a personal benefit as a result of the oppressive conduct from the dilution of the appellant’s class “A” and class “B” shares. The respondent further benefited as a result of the conversion of his own class “C” shares prior to the Private Placement by increasing his control over the Corporation, to Mr. Alharayeri’s detriment.

The extent of the appellant and Dr. Black’s liability, the value of the number of common shares the respondent was entitled to had his class “A” and class “B” share options been exercised, went no further than necessary to rectify the situation.

Mr. Alharayeri reasonably expected that his class “A” and class “B” shares would be converted if the Corporation met the applicable financial tests, thus the remedy appropriately vindicated Mr. Alharayeri’s reasonable expectations as to those shares.

As a result, the trial judge’s order against the appellant was upheld.

The key takeaway is that directors will be held liable to the extent they were involved in the oppressive conduct, derived a personal benefit or created a detriment, and exhibited bad faith. Whether a Court finds oppression in any given case depends on the facts involved. The Supreme Court emphasizes that personal benefit, for example, is just one of several indicia. If a director were only tangentially involved in the oppressive conduct, he or she may not be found personally liable even though a personal benefit was derived. What constitutes “personal benefit” may also be challenging to pin down. Does an increased shareholding necessarily imply that a personal benefit was derived? Surely the company’s finances should be taken into account in that analysis. While Wilson v Alharayeri clarified the test for director liability, the determination as to whether there was oppression for which a director is personally liable is, as ever, a fact-specific exercise.

Invitation for Discussion:

If you would like to discuss this blog in greater detail, or any other business litigation matter, please do not hesitate to contact Mohamed Amery or one of the lawyers in the Business Litigation group at Shea Nerland LLP.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.